BLOG: Why investment trusts are perfect for your ISA
We agree and we view it as one of the most efficient ways to invest for your future – three cheers for Mr Osborne who increased the annual ISA limit to £15,000 in this year’s Budget.
Deciding what to put in your ISA is difficult though and we do not deny the sea of choice out there. Because of this, we bring you one (largely unknown) corner of the investment market that we think may be perfect for your ISA: investment trusts.
Investment trusts are closed-ended investment companies; they have a fixed amount of money to invest for their particular mandate i.e. growth, income, or a mix of both; from a wide range of geographical or sector specialisations. Investors wishing to buy into them buy shares in the investment trust company, as you would BP or Barclays.
This differs from open-ended funds; if they experience sudden and significant redemptions the fund managers may find themselves selling positions on the basis of liquidity needs rather than preference, which may adversely affect performance. The effect is to constrain the investment manager, both in terms of having to maintain a level of liquidity and in the time horizon for the investments.
Investment trust managers do not need to concern themselves with maintaining a level of liquidity to fund redemptions; the number of shares in issue stays put, allowing them a longer-term investment view where more opportunities may exist as well as the option to buy more esoteric or illiquid assets. Because ISAs are about investing for the long-term we think this makes investment trusts a sensible choice in your ISA.
There are further advantages.
Investments in ISAs in general do not attract any income tax on dividends paid-out by the investment vehicle.
Investment trusts offer a further advantage: the manager is able to hold in reserve up to 15% of the pot of income received from the underlying assets, whereas managers in open-ended funds do not have this privilege. Because investment trust managers can retain earnings, usually during buoyant economic periods, when less favourable market conditions arise they are able to dip into that reserve to maintain or indeed increase dividends. It makes for a smoother income flow and, as such, can make investment trust dividends less volatile. The City of London Investment Trust, for example, has achieved 47 years of consistently rising annual dividends, through all types of bear and bull markets. No other equity investment vehicle can manage this sort of income stability although investors should note past performance is not a guide to future performance.
Investments in ISAs also avoid capital gains tax (CGT). Investment trusts again offer a further advantage to aid capital growth: they have the option to borrow money with the aim of enhancing returns over and above its costs. This feature – known as gearing – enables the manager to purchase a greater number of stocks during bullish market periods, such as the one we are now, utilising a potentially greater number of opportunities and adding to any capital gains made. Of course, gearing is a double edged sword and will enhance losses if markets fall.
£15,000 is certainly a significant sum to consider investing but not if you already have savings and investments that are not in a tax free wrapper. The ISA allowance should not be wasted if the investor has any assets where the taxman is taking an interest. ISAs are fully excluded from tax returns so require little thought at the end of the tax year.
Many informed investors have investment trusts in their stocks & shares ISA; you should join them.
James de Sausmarez is director and head of investment trusts at Henderson